Right to Rent: Helping the Market to Find a Bottom

Recent data on existing home sales and construction indicate that the housing market may be moving up slightly from the low-points reached earlier this year. The 4.77 million annual rate of sales reported for May is more than 6.0 percent above the low hit in January. The 582,000 annual rate of housing starts reported for June is almost 20 percent above the January low, although the 6 percent gain in permits, which are less weather-affected, is considerably less impressive.

Nonetheless, it seems more likely that the general trend in sales and construction going forward will mostly be positive, even if the rate of increase will be very slow. Unemployment and underemployment will continue to hit both ends of the market. Many people losing their jobs will be forced to sell their homes. With the unemployment rate virtually certain to cross 10 percent and likely to remain in double digits throughout 2010, this will be a big issue. Underemployment (currently more than 9 million workers are involuntarily working part-time) will also prevent many families from getting the income needed to buy a home.

Interest rates are also likely to be less helpful going forward as the general trend for mortgage rates will be upward. In fact, the rise in sales in May was probably in part a rush to take advantage of the historically low rates available in April. Sales could therefore drop off in subsequent months.

Prices in many bubble markets have now reverted most or all the way back to their trend levels. In some cases, notably Phoenix and Las Vegas, they are overshooting their trend with real house prices now below their mid-90s levels. In both cities, sale prices have fallen relative to rents to 1996 levels.

Price declines of this sort can be self-reinforcing. While there is always some inflow of new residents to a city (less so, when its economy is collapsing), the bulk of homebuyers will be people who already live in the city. With prices plummeting, more existing homeowners go underwater in their mortgages or at least lose most of the equity they have in their home. This makes them less able to afford the down payment on a new home, putting them in a situation much like first-time homebuyers.

In addition to constricting demand, price declines can also increase supply, as falling prices make it more likely that people will face foreclosure. At the current rate, we will see more than 2 million foreclosures in 2009, a number that is equal to roughly 40 percent of new and existing home purchases.

Stemming the tide of foreclosures will be an important step in stabilizing the housing market. Thus far, the various programs for promoting loan modifications have had very limited success. While incentives for lenders have gotten larger in each iteration, only a very small percentage of homeowners facing foreclosure have thus far benefited from these programs. None of them has been successful in preventing the pace of foreclosure from accelerating.

A simple alternative would be to give homeowners facing foreclosure the option to stay in their home as renters for a substantial period of time (7-10 years), paying the market rent. This measure would immediately give millions of homeowners security in their homes, since they would be able to stay there as long as they could afford the market rent. It also would give lenders a much stronger incentive to negotiate terms that would allow homeowners to stay in their homes as owners, since foreclosure would be a much less attractive option to banks if it could lead to them being landlords for a decade.

There appears to be widespread sympathy for the homeowners who got caught up in the housing bubble. At the same time, there are many people who are struggling to pay their mortgages who resent the idea that their tax dollars will be used to subsidize the mortgage of their neighbors. A right to rent law could steer a middle course by providing immediate aid to homeowners facing foreclosure, while not using any public funds. By reducing foreclosures, it will also help to stabilize house prices.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.